Tullett Prebon plc Annual Report 2010
Policies and procedures exist to reduce the likelihood of such trade mismatches and, in the event that they arise, the Group’s policy is to close out such balances immediately. All market risk arising across the Group is identiﬁed and monitored on a daily basis. 2. Credit risk The credit risk faced by the Group consists of counterparty credit risk (as opposed to issuer risk), and principally arises from the following: – Pre-settlement risk arising from Matched Principal broking; – Settlement risk arising from Matched Principal broking; – Cash deposits held at banks and money market instruments; and – Name Give-Up brokerage receivables. In addition to counterparty risk, the Group is also exposed to concentration risk in the level of exposure to counterparties, representing the aggregate of the exposures arising from Name Give-Up brokerage receivables, unsettled Matched Principal transactions or cash on deposit.
Settlement risk is the risk that on settlement date a counterparty defaults on its contractual obligation to make payment for a securities transaction after the corresponding value has been paid away by the Group. Unlike pre-settlement risk the exposure here is to the full principal value of the transaction.
In practice the Group is not exposed to this risk as settlement is almost invariably effected on a ‘Delivery-versus-Payment’ (‘DvP’) basis. ‘Free of payment deliveries’ (where an immediate exposure arises due to the Group’s settling its side of the transaction whilst receipt of the countervalue is at some future date) occur very infrequently and may only be effected under the application of stringent controls.
Cash deposits – The Group is exposed to counterparty risk in respect of cash deposits held with ﬁnancial institutions. The vast majority of the Group’s cash deposits are held with highly rated clearing banks and settlement organisations (as set out in the Credit risk analysis in Note 25 to the Accounts).
As with trading counterparties, cash deposit counterparty exposures and limits are kept under constant review and steps taken to reduce counterparty risk where market conditions require.
GOVERNANCE SHAREHOLDER INFORMATION
Pre-settlement risk arises in the Matched Principal broking business in which Group subsidiaries interpose themselves as principal to two (or more) contracting parties to a Matched Principal transaction and as a result the Group is at risk of loss should one of the parties to a transaction default on its obligations.
The risk is that the counterparty may default prior to settlement date, in which case the Group would have to replace the defaulted contract in the market. This is a contingent risk in that the Group will only suffer loss if the market price of the securities has moved adversely to the trade price over the period between the trade and ﬁnal settlement date. Counterparty exposures are kept under constant review and the Group will take steps to reduce counterparty risk where market conditions require. Particular attention is paid to more illiquid markets where the price movement (and hence the mark-to-market credit exposure) is more volatile, such as trading in GDR, ADR and emerging markets instruments.
Name Give-Up brokerage receivables – The majority of transactions brokered by the Group are on a Name Give-Up basis, where the Group acts as agent in arranging the trade and is not a counterparty to the transaction. Whilst the Group does not suffer any exposure in relation to the underlying instrument brokered (given that the Group is not a principal to the trade), it is exposed to the risk that the client fails to pay the brokerage it is charged. Debtors arising from Name Give-Up brokerage are closely monitored by senior management. Concentration risk – The possibility of concentration risk exists in the level of exposure to counterparties. The Group controls its credit exposure to counterparties and groups of counterparties through the application of a system of counterparty credit limits (based on the mark-to-market exposure for Matched Principal trades, outstanding brokerage receivables for Name Give-Up trades, and amount on deposit for cash deposit exposure). Counterparty limits are set by the European and North American Credit Committees according to a methodology agreed by the Group Treasury and Risk Committee.